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Tuesday, February 13, 2018

The first thing to know is that Bitcoin is not blockchain; even though both were released to the world concurrently by the pseudonymous “Satoshi Nakamoto” in 2009.

What is blockchain?

Visualize that using Windows requires certain hardware in the computer. However, that same hardware could, with minimal modification, run the Macintosh or Linux operating systems – or control a printing press or a heart-lung machine. Similarly, the blockchain infrastructure could replace a stock market or create a firearms registry that might satisfy all sides of the argument.

In addition to monetary exchange; blockchain has been suggested as a ledger for contracts, ownership titles, artwork provenance; even identity documentation and voting. All of these uses are attracted by the ability to store encrypted, incorruptible data without a central depository.

And that is all I understand about blockchain. That statement is comparable to “all I know about carburetors.” I can tell you its value and where it’s likely to be used; but could not build or configure one. I do know to hire someone so immersed in the technology of blockchain that they can’t name the pope if I need one.

What is Bitcoin?

Bitcoin is a cryptocurrency that purports to allow the transfer of value potentially instantaneously and with anonymity. In reality, it has become a cross between trading stamps and tulip bulbs. It has no real value and is scarce, so it increases in price until the holders decide to take their profits or the bubble bursts merely from overinflation. As the price falls, the last buyers in try to rescue their value; accelerating the cascade as more and more people take a loss.

Where do bitcoin come from?

Bitcoin are mined by performing a computational task. The task is designed so that as more bitcoin are added to the global inventory, it takes greater computing power or time to create the next one. In the beginning, they could be mined on typical desktop computers (I know of a person who installed the mining program on one computer and the next morning had 50 bitcoin. Had he used it immediately, that amount would have covered his Valentine’s dinner – if the wine weren’t too expensive.) Now it requires networks of special-purpose computers to create a single bitcoin. The electricity to power the computers and associated cooling costs more than their return in all but the least expensive energy markets. Meanwhile, the total number of bitcoin extant will never exceed a finite amount – about 21 million – no matter how many computers work at it.

How do you use your bitcoin?

Bitcoin are held in a wallet – an encrypted computer file – that you have to keep track of. Your “account” is a long random code with no connection to you other than that only you can decrypt the wallet. You send bitcoin to another person by using their anonymous account code. The clever point is that you can transfer a miniscule fraction of a bitcoin so; when they are “valued” at $10,000, you can still buy a donut for a reasonable price.

At the transfer is where blockchain kicks in. The transaction to decrease your holdings by 0.0001 bitcoin and increase the donut shop’s by the same amount is encrypted and recorded in the blockchain ledger. Then the new blockchain is duplicated in everyone’s account. While your true identities are unknown, the transaction can’t be erased or hidden from the record without collusion from many millions (>50%) of users to modify it.

What is bitcoin good for?

Originally it was expected to be a “currency franca” that could transcend units of value, time, distance, and borders. Consumers would carry their bitcoin in a wallet app to spend with a click at merchants. A few businesses and online sites did accept bitcoin. These were primarily local shops or online services and subscriptions; although some national chains attempted to honor it.

It also could be used to move money across jurisdictions for legitimate purposes such as remittances to families or refilling a student’s account. In theory; the speed, convenience, and transaction costs would be far more favorable than conventional wire transfers or transfer agents such as Western Union.

It’s also good for anonymous transfers and money laundering for good and evil uses. This is why it’s used by extortionists and merchants of illegal or illicit goods.

What’s wrong with bitcoin?

The difficulty of trying to establish bits as a conveyor of value is that there was no entity to define its value. When John Reed found his yellow rock in 1799, he may have thought it a pretty doorstop; but a jeweler from the big city told him what it was really worth. The value exists because there was a market where people would give you government-backed currency for your gold.

But bitcoin has no intrinsic value and no central bank sponsorship to establish a stable exchange rate. Like tulip bulbs, it’s worth whatever item of value someone will give you for it. This could be donuts (a barter trade) or dollars (a speculative offer).

If you don't like the value you're offered, you can always make jewelry from your gold or plant the bulbs and have a nice garden.

Since not everyone could mine the bitcoin they needed and merchants couldn’t pay their staff in the bitcoin they received, exchanges sprang up to sell and buy bitcoin for hard currencies. Unfortunately, these exchanges are unregulated by anyone and may be as reliable as the person with a card table outside the Dakar airport offering you francs for your dollars.

When you hear about bitcoin heists taking millions and millions of dollars’ worth of bitcoin it has actually been stolen from the exchanges. There’s no FDIC to regulate cryptocurrencies and indemnify coin holders. Once you turn your wallet over to an exchange to facilitate converting it back to dollars, any flaw in their system can put your money at risk. The blockchain has not been compromised and the security of your stash is dependent on the security of how you protect your wallet.

So, where does $16,000/bitcoin come from?

Bitcoin has been a speculative entity since its value passed $10. The exchange rate does not represent hyperinflation from too many coins chasing too little merchandise. Nor is it from scarcity of an item of value (although the quantity of bitcoin are finite) because it has no value beyond the market. Any price is merely the result of people buying now on the assumption they can sell for more later. But all bubbles burst … sometime.